Geoff Wilson and Philipp Hofflin share three lessons from investing in a recession

Sara Allen

Livewire Markets

There’s a lot of talk of recessions at the moment – and that’s saying something, given Australia is not in a recession (at least at this stage). In fact, it isn’t even in a bear market according to some experts. 

Perhaps, it is that the global news has rubbed off locally. Did you know the last time Australia technically experienced a recession was 1991-2? That’s right, the GFC didn’t hit quite as hard as we all thought at the time.

If we look back, there’s a key thing that stands out in the lead-up to the 1991-2 recession and that’s interest rates rising. Sound a bit familiar? Hands up all those who were *thrilled* to hear their mortgage repayments were going to jump again last Tuesday (yep me and my many counterparts who have never had to deal with a rate rise).

But it’s not all that it appears.

I spoke to two industry stalwarts, Geoff Wilson AO, Chairman and CEO at Wilson Asset Management and Dr Philipp Hofflin, Portfolio Manager/Analyst at Lazard Asset Management about investing in recessions and just what is going on right now.

History never repeats itself, but it rhymes

Let’s take a little journey down memory lane to a time where boxy blazers and mom jeans were in… Sorry, let me be clear – the first time these items were trendy in the late 80s/early 90s. (The similarities keep coming…)

Here’s some context.

The Hawke/Keating government had granted international banking licenses in 1985 so domestic banks were spooked and doing everything to retain market share (read: big loans,  high debt across Australian corporates). There was a global stock market crash in 1987 and Australia had never really recovered. This was also the time of the entrepreneurs who made up 10% of the market, Bond and Skase were just two names. But inflation was high and here’s where our tale of interest rate rises begins.

You’ve heard the horror stories about mortgage rates of 17%. The effect on the economy was slow until suddenly, a recession hit.

“There was pain in a lot of sectors and gearing was the common factor. Corporate debt had risen too far in the 80s whereas this time, the problem is household debt,” Hofflin says.

Wilson shares this view, noting that in any downturn, those companies with high levels of debt are at significant risk. Unfortunately, it was the case that many held high debt at the time and therefore, either came very close to the line or failed completely.

Hofflin found the least affected areas then were global exporters. While there was a global recession, it was milder than the domestic one and the falling Australian dollar was a huge benefit. While it’s hard to predict, this is not necessarily going to be the case if we have a recession this time. Especially given some of our primary markets are in a serious slowdown, being the US and China.

The general consensus?

“The similarity is that interest rates are increasing but it’s a different backdrop,” Wilson says. 

In fact, Hofflin suggests if we want to compare history, the environment bears a closer resemblance to the recession of 1973-4.

The oil crisis was a significant driver in that recession (energy supply issues today anyone?) and inflation was persistent across the recession despite monetary policy.

The good news from the experts is that we’re very unlikely to see mortgage rates reach 17% in the next two years (I can hear that sigh of relief from here). However, house prices are vastly different to the past and Australians have significantly higher leverage in their mortgages so even getting to 3% might be a bit painful.

Back to the future (with some experience in hand)

Both Wilson and Hofflin are uncertain about the future, but view recession as being likely at some point in the next 18 months. They warn that even if interest rate rises feel like an instant hit (because Australia is highly interest rate sensitive), that doesn’t mean we’ll be in a recession straight away. It can take time for monetary policy to really flow through.

These are the key lessons they have learnt from the past which they still use today.

1. Recession is not a dirty word, it’s a fact of life

“Recessions still happen but they always end, you invest for the long term,” Hofflin says. 

Further to this, Wilson believes that they offer a vital market reset, as painful as they can be. He points to how easy it has been to make money in the past decade, particularly in crypto-markets and it’s not normally that easy. A slowdown brings sanity back to investing, forcing investors to go back to the fundamentals and do their research. It’s also a time where the strong companies will survive (and sometimes even flourish), while the weaker ones will either fail or be taken over – so a refresh for the market.

2. Beware of high gearing

Both for yourself and in the companies you invest in. High debt levels are dangerous in downturns – although Wilson has found identifying those companies that are likely to go close to the wire but recover can be lucrative investments. This is a tactic the average investor might be best leaving to the experts, I certainly will be.

“Look at the companies with good balance sheets, low levels of debt and the ones with strong business franchises as these have the potential to prosper, even in difficult times," Wilson says.

3. Hold cash

You need cash for a few reasons. The first is to cover debt regardless of what is going on and avoid a situation where you are forced to sell at a loss. The ability to wear temporary pain as Hofflin puts it. The second is to take advantage of opportunities.

“You want markets to fall because it allows you to buy fantastic companies cheaply. Find high quality franchises and buy them when they are undervalued," Wilson says. 

Both believe it is important to keep the emotion out of your decisions and remember that market cycles are simply part of the investment experience – you invest for the longer term after all. It should go without saying that if your portfolio is adequately diversified across assets that perform differently in different market cycles, then you are already on the right track.

On a positive note, how you set yourself up during a recession can reap rewards in the next bull run – there’s a reason why value investors love bear markets.

The top spots for tough times

If you’re looking for a few safe havens in equities to prepare for a downturn, there are a few places to look. Consumer staples, utilities and healthcare are typically stable. You might also find some opportunities from the lipstick effect (see article here).

But when it comes to a couple of names, the experts have some thoughts.

Hofflin is eyeing Coles (ASX: COL) and Woolworths (ASX: WOW), with a preference for Coles – it has no debt and a strong balance sheet. If we end up in the type of recession seen in 1973-4 where inflation is persistent, he likes Woodside (ASX: WDS) because there is little debt following the BHP (ASX: BHP) merger and it also stands to benefit from the energy supply issues.

Wilson is focusing on undervalued growth with a catalyst and Telstra (ASX: TLS) has been a surprise recommendation. That is – a surprise to him after years of Telstra having no growth (and a surprise to me after thinking that Telstra was one to avoid for years).

“After a decade of no growth in mobile – its major segment – it is seeing growth and mobile will be the last to disconnect in a recession. Mobile use is the new recession-proof. It wouldn’t have been on my radar previously," he says. 

You can read more about Telstra’s changing fortunes in this article by my colleague Mure Feng.

No pain, no gain?

It’s worth remembering that bear markets and recessions usually last half the time of a bull market. But in any case, I think I’ll leave you with some wisdom from Wilson for that glass-half-full feeling.

Just before his first recession in 1982, a broker told him that you make your money in the second bull market. Take that in for a second. You become invested in the first bull run, and make some losses in a recession, but if you hold your course and make careful well researched decisions, you could stand to gain more in your second bull run.

Interested in hearing more from the experts in this article? Follow Geoff Wilson AO and Dr Philipp Hofflin by selecting their profiles. 


2 contributors mentioned

Sara Allen
Content Editor
Livewire Markets

Sara is a Content Editor at Livewire Markets. She is a passionate writer and reader with more than a decade of experience specific to finance and investments. Sara's background has included working at ETF Securities, BT Financial Group and...

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